Lessons From the Cornell Excess Fee Dismissal – Investment and Recordkeeping Fee Changes Are Proof Positive of Proper Fiduciary Management

By Daniel Aronowitz 

Most of the focus on the November 14, 2023 decision from the Second Circuit Court of Appeals in Cunningham v. Cornell University will be on the pleading standard for prohibited transaction claims.  Beyond this important ruling, however, is the question whether the fiduciary imprudence cases that the Schlichter law firm and others brought against Cornell and nineteen other large universities in 2016 and 2017, many of which have settled for substantial sums, were legitimate cases.  In other words, now that we have a case that did not settle with a full evidentiary record, did the Cornell fiduciary committee have a deficient fiduciary process that justified having to defend itself in an eight-year odyssey?

The summary judgment record, which was upheld on appeal, suggests the opposite – that the Cornell fiduciary committee had a robust fiduciary process as demonstrated by a series of calculated changes over the course of many years.  After years of deliberation under the guidance of a leading financial advisor, Cornell fiduciaries made drastic and wholesale changes to its entire investment menu.  This is the opposite of the typical Schlichter law firm imprudence trope that plan fiduciaries were “asleep at the wheel.”  The record also showed that the Schlichter law firm filed the Cornell lawsuit without any knowledge of the actual fiduciary processes of the fiduciary committee.  Even after full discovery, plaintiffs could not assemble convincing proof that Cornell fiduciaries had a deficient fiduciary process.  The Cornell case is just another example of a fiduciary imprudence case based on circumstantial evidence of a disfavored outcome – an obsolete fact pattern of legacy fees and investments held by nearly every large university plan in the country that Cornell ultimately changed as the investment and retirement plan market evolved.

The Schlichter law firm has now suffered three significant losses in 2023, if you include the Cornell appellate decision with the defense verdicts in the Yale and E.B. Braun trials.  The plan sponsors prevailed in these three cases because they proved their fiduciary processes with evidence of investment and fee changes.  As we discuss below, the key lesson of the Cornell case, like the Yale trial, is that the best proof of a fiduciary process in an imprudence case is to show a pattern of investment and fee changes over a course of years.  This is how the Mayer Brown defense team achieved two of the most important plan sponsor victories of the year.

The Cornell Prohibited Transaction Ruling

The federal appellate courts have established different pleading standards for prohibited transaction claims, with the most recent case allowing a liberal pleading standard in the recent AT&T decision.  (See https://www.euclidspecialty.com/under-the-ninth-circuits-prohibited-transaction-ruling-atts-20-recordkeeping-fee-is-presumed-imprudent-until-plan-fiduciaries-can-prove-otherwise-in-high-risk-litigation/)  Plaintiffs asserted on appeal that their prohibited transaction claim was sufficient as long as they alleged that because “TIAA and Fidelity are service providers and hence ‘part[ies] in interest,’ their ‘furnishing of’ recordkeeping and administrative services to the Plans is a prohibited transaction unless Cornell proves an exemption.”  The Court rejected this minimal pleading standard, and held that the burden fell on plaintiffs – not plan fiduciaries – to allege in the first instance that the disputed transactions were unnecessary or that the compensation paid to service providers was unreasonable.  The reasoning of the Court was that the prohibited transaction exemption for necessary and reasonable compensation was part of the “ingredient” of the law.  Thus, “to state a claim for a prohibited transaction pursuant to 29 U.S.C. § 1106(a)(1)(C), [the Court held that] it is not enough to allege that a fiduciary caused the plan to compensate a service provider for its services; rather, the complaint must plausibly allege that the services were unnecessary or involved unreasonable compensation, see id. § 1108(b)(2)(A), thus supporting an inference of disloyalty.”  The Court held that the reasonable compensation exemptions limit the scope of the prohibited transaction statute’s prohibitions “to only those transactions that actually present a risk of harm to the plan and raise the sort of concerns implicated by the duty of loyalty.”

Plaintiff had alleged that the “Retirement Plan paid between $2.9 and $3.4 million (or approximately $115 to $183 per participant) per year from 2010 to 2014” for recordkeeping services.  But the Court held it is not enough to allege that the fees were higher than some theoretical alternative service:  “Whether fees are excessive or not is relative ‘to the services rendered,’ [citation omitted], and it is not unreasonable to pay more for superior services.  Yet, here, Plaintiff have failed to allege any facts going to the relative quality of the recordkeeping services provided, let alone facts that would suggest fees were ‘so disproportionately large’ that they ‘could not have been the product of arm’s-length bargaining.’”

The Court limited this stringent pleading standard to prohibited transaction claims, but this is the test that should apply for prudence claims as well.  Excess fee claims should have proof that the fees are egregious, as compared to a legitimate and credible survey showing what similar plans pay for similar services of similar quality.  Too many cases allow claims to survive in which the alleged excess fees are not proven to be even above the average for similar plans, let alone representing fees that are outliers from the normal market.  Excess fee claims should require an amount that is disproportionate to the market for similar services.

Cornell Prevailed Because It Showed a Pattern of Fiduciary Process Improvements

On appeal, plaintiffs took the position that they need only “show an expenditure for recordkeeping fees” to “establish a genuine dispute regarding loss.”  This is a striking position.  If accepted, it would allow plaintiff lawyers to challenge nearly every plan and second-guess their fiduciary decisions.  This is what plaintiff lawyers want.  Fortunately, the Court held that “[t]his misunderstands” the burden of proof to establish fiduciary imprudence.  “Plaintiffs must do more than establish only that some payment was made; they must also show, at a minimum, that there was a ‘prudent alternative’ to the allegedly imprudent fees paid.”  The Court continued that “Plaintiffs must provide evidence of a “suitable benchmark[]” against which loss could be measured.”

It is important to remember what evidence was used by the Schlichter law firm to establish that university plans like Cornell should have paid $35 per participant or one million in total for recordkeeping fees.  The answer is none.  The complaints in these cases had no benchmark.  The modern excess fee complaint conjures up a chart of a few large plans that purport to show that these random plans are somehow representative of the entire universe of large plans.  But the Schlichter 2016 complaints alleged a $35 recordkeeping fee as the appropriate amount without any proof.  Nothing – it was derived out of thin air.  We have always been upfront that we were sympathetic to the firm’s concerns about uncapped revenue sharing alleged in the university cases, but Schlichter complaints nevertheless failed to provide a suitable benchmark to validate their claims.

The evidence at the summary judgment stage after full discovery was no better.  With respect to alleged excess recordkeeping, Plaintiffs proffered the same “expert” witnesses that appear for plaintiffs in most cases:  Al Otto and Ty Minnich.  According to the Court, both declared that in their “experience” – and the court used quotations around that term – a reasonable recordkeeping rate for the Plans would have been $35 to $40 per participant.  “But neither offered any cognizable methodology in support of their conclusions, instead simply referencing their knowledge of the relevant industry and a few examples of other university plans that paid lower fees, though without explaining how these putative comparisons were selected.”  Apart from the unsupported expert testimony that the district court excluded, the only other evidence was what the Court disparaged as “scattered numbers” of plan participants, assets and recordkeeping fees for a few plans from CAPTRUST and TIAA.  For example, plaintiffs had TIAA pricing data showing that the Cornell plans paid higher than the 25th percentile of TIAA’s largest 200 clients; and CAPTRUST data identifying a “handful of plans” with over 10,000 participants that paid lower recordkeeping fees.

In sum, after years of discovery, the Schlichter law firm still was unable to assemble a reliable, national survey of what large university plans actually pay.  The reason:  because the Cornell plan paid what most other university plans paid during the same time period.  There was never any proof that the twenty university plans sued for fiduciary imprudence paid more than most other similarly sized plans.  Schlichter law firm lawyers may not like the recordkeeping arrangements that existed from 2010 – 2015 for large university plans, but this was industry standard.  Again, we have some sympathy for their position on revenue sharing and even on the fee amounts, but the answer was never to file fiduciary breach cases.  Plaintiff law firms are not legitimate regulators or police for the national fiduciary standard.  That is why the Department of Labor exists.  And as shown below, Cornell and other plans made significant changes as the market changed.  We predict that the same evidence will surface in the ongoing Northwestern case.

Plaintiff next argued that both Cornell and CAPTRUST employed a flawed process in reviewing the set of investment options made available through the plans and failed to remove underperforming options.  These are common claims in excess fee and performance cases, but the Court was not persuaded.  Cornell hired CAPTRUST as an investment advisor in 2013, so plaintiffs had arguments for both before and after the hiring of CAPTRUST.  Before 2013, plaintiffs argued that Cornell lacked a sufficient process to review the performance of TIAA and Fidelity investment options.  After 2013, plaintiffs argued that CAPTRUST failed to review the investment options for nineteen months after being hired, and then conducted a review that “was of generally lower quality than its work for other clients.”  The court found that there was not sufficient evidence to support these theories that Cornell’s fiduciary process was flawed.

Specifically, prior to the 2013 hiring of CAPTRUST, Cornell had processes to review the plan’s investment options, including review of detailed performance and investment disclosures by Cornell’s Benefits Department, which included investment disclosures from Fidelity and TIAA.  Cornell’s witness from the fiduciary committee admitted that the process improved over the years, but testified it was consistent with then-prevailing standards.  In 2013, Cornell engaged CAPTRUST to launch a multi-year process focused on redesigning and streamlining the investment menu.  After a new Investment Policy Statement was drafted, the Court held that “Cornell initiated a much more systematized and in-depth review of the investment options, beginning in earnest with CAPTRUST’s presentation of its performance analysis in July 2013.”  Plaintiffs accused Cornell fiduciaries of “passively accepting CAPTRUST’s” recommendations, but the Court held that the “undisputed evidence show[ed] that the [Cornell fiduciary committee] engaged critically with CAPTRUST’s presentation, asking questions and, at times, expressing concern about CAPTRUST’s methodologies for evaluating particular investments.  Importantly, Cornell’s review of the Plans ultimately led to the rollout of a new investment menu beginning in 2017.  The streamlined investment menu was a “drastic change” from the legacy investments at issue in the lawsuit.  In sum, it is possible for plaintiff lawyers to criticize and critique every plan’s fiduciary process, but it is unfair Monday-morning quarterbacking in most cases, especially when plan fiduciaries are guided by sophisticated investment managers.

As for CAPTRUST, the Court held that “Plaintiffs offer no evidence that it carried out these tasks in a subpar way.”  Plaintiffs’ only argument was nitpicking that CAPTRUST’s July 2013 presentation to the Cornell fiduciary committee had less detail than a presentation to another university.  Again, plaintiff lawyers are in no position to critique the fiduciary process of a top-line investment manager.

Evidence of Manufactured Lawsuits is Influential to the Factfinder

Footnote 15 on page 46 of the decision is worth reading.  The Court stated that “though we do not rely on it, we observe that the fact that Plaintiffs’ counsel have brought claims on similar purported process failures against numerous other university plan fiduciaries tends to undermine the argument that such processes fell below the then-prevailing fiduciary standard.”  The Court cited the Schlichter firm’s Petition for Writ of Certiorari to the Supreme Court in the Hughes v. Northwestern case in which they noted that actions against various university 403(b) plans have all involved “substantively identical” allegations.  We believe that defense firms need to point out that excess fee cases like the Cornell case are manufactured cases by plaintiff law firms in which no participant had previously complained of harm, but merely responded to marketing by plaintiff lawyers in their attempt to create a lawsuit.  This evidence was persuasive in the Yale trial to the jury as well.

The Euclid Perspective

The operating premise of excess fee lawsuits is that plan sponsors are “asleep at the wheel” in managing large retirement plans, allowing large service and investment providers to charge high fees for underperforming investments.  The subtext is that the fiduciary universe needs plaintiff law firms to police retirement plan fiduciaries by filing lawsuits to ensure proper fiduciary oversight of large plans.  The Cornell and Yale cases show otherwise.  Most cases are settled, so we never get to see the actual fiduciary process of these jumbo retirement plans.  We usually only see the plaintiff law firm narrative in filed complaints in which lawyers second-guess fiduciary processes as if they are investment experts.  The truth is that the vast majority of large retirement plans in America are well managed by thoughtful committee members, nearly all of which are advised by sophisticated investment managers with significant experience.  There is no groundswell of participant discontent of the fees and results of large defined contribution plans.  To the contrary, as the Cornell Court implied, these cases are contrived and manufactured by plaintiff law firms as a way to generate legal fees.

On a more specific level, we end with the key lesson of the Cornell case, as derived from analysis of Mayer Brown’s defense work in both the Cornell and Yale court records.  While most excess fee cases are based on speculation and circumstantial evidence asking courts to infer a deficient process, the best way to demonstrate a robust fiduciary practice is to show a track record of changes to investments and fees.  Given the fee compression of the last decade, plan sponsors should proactively assemble evidence of investment and fee changes as the landscape has evolved.  We would be the last to defend the legacy fees of the university plans when TIAA had a near monopoly on university plan investments in 2010.  But the investment world has changed, and large plans that have changed with it will be best prepared to defend capricious fiduciary imprudence lawsuits.  From our perspective, the lesson of the Cornell case is how to defend a plan’s fiduciary process – and that is to show a pattern of changes and lower fees over time.  When fiduciary changes are placed in this proper context, the recent track record of decisions shows that both judges and juries can best understand fiduciary process by watching the evolution of plan changes under the advice of thoughtful investment advisors.  Plan fiduciaries should not have to defend their fiduciary process based on flimsy speculation.  But until the federal pleading standard is more circumspect of unfair fishing expeditions, the Cornell defense provides valuable lessons for plan sponsors unfairly accused of fiduciary malpractice.